Grail Investing

We’ll go back 10 years to September 30th, 1999. What if I told you back then that the S&P 500 would be down over the next 10 years? What if I could guarantee that I would be right? What if you believed me? Certainly, that would be great information to have. What a head start you would have in making your investment decisions over the coming 10 years. But I’m betting that most of you would take that information and decide not to invest in the stock market. That would make sense since you already knew that it wouldn’t be going up over the next decade. But, what if, even with the benefit of a time machine, you were wrong?
– Joel Greenblatt

Joel Greenblatt is making the point that if you had known ten years ago that the stock market would be down for the next ten years you probably would have avoided investing in stocks like the plague. But that would have been a huge mistake.

Why?

Because if you had invested in stocks using Greenblatt’s Magic Formula you would have almost quadrupled your investment even while the overall market was down. And that’s because we don’t have a stock market. We have a market of stocks.

Even though the overall market may be weak there are always individual stocks, industries, and sectors that are quite strong. Or, as the saying goes, “there’s always a bull market somewhere.” It is our goal to find the strength — or what may have potential for strength — and get on board.

Speaking of Joel Greenblatt and the Magic Formula, I did a little playing with numbers. During 2009 we bought twenty MF stocks and staggered the purchases — five in March, five in May, and ten in June. The idea was to hold them for a year and then replace them with new MF stocks. And at the end of 2009, we had a return of +35.89%. It was a very good year for the Magic Formula.

But if you recall, with future MF purchases we are going to protect positions with a 3 times the 20-day Average True Range (ATR) indicator as a stop loss on the initial purchase. And we’re only going to risk a small percentage of equity with each position — maybe 2%.

Doing a little back-0f-the envelope figuring, had we taken that approach in 2009 we would have owned nine stocks instead of twenty, and the return would have been roughly+50% rather than +35.89% — all the time not risking more than 2% of equity with each position. The difference in performance is just a mater of better risk management and better position sizing.

The Gold Base

Before we move on to the various strategies, I want to show you something that I think is important about gold.

See the gold horizontal line on the chart? That line represents gold at $1,000 an ounce. Gold tried to break through $1,000 an ounce in the first quarter of 2008 and failed. It tried again in the first quarter of 2009. It failed again. It tried a third time in September of 2009 — success! The third time was a charm.

I think there is a very good chance that $1,000 an ounce will prove to be a base of support many years in the future. It happened with oil when it finally broke above $40 a barrel in 2004. And I think something similar may have happened with gold at $1,000 a ounce.

I don’t mean that to be a prediction. I could very well be wrong. And, if so, I’ll change my mind — or rather the market will change my mind for me. But it helps give me a framework to understand where the price of gold may be in relation to its long-term trend.

So some people may look at gold at where it is now — approximately $1,100 an ounce — and think it’s expensive. I look at $1,100 an ounce as fairly close to its long-term base. Therefore, $1,100 seem like a pretty good deal to me.  But as always we will see.

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